Focus: As U.S. inflation hits 31-year high, banks assess risks and opportunities
23/11/2021 14:00
By Matt Scuffham
NEW YORK, Nov 23 (Reuters) - Wall Street banks are planning
for a sustained period of higher inflation, running internal
health checks, monitoring whether clients in exposed sectors
could pay back loans, devising hedging strategies and counseling
caution when it comes to deals.
U.S. consumer prices this month posted their biggest annual
gain in 31 years, driven by surges in the cost of gasoline and
other goods. urn:newsml:reuters.com:*:nL1N2S11BJ
Senior bank executives have become less convinced by central
bankers' arguments that the spike is a temporary blip caused by
supply chain disruption and are stepping up risk management.
Higher inflation is generally seen as a positive for banks,
raising net interest income and boosting profitability. But if
it jumps high too quickly, inflation could become a headwind,
top bankers warn.
Goldman Sachs Chief Operating Officer John Waldron last
month identified inflation as the No. 1 risk that could derail
the global economy and stock markets. urn:newsml:reuters.com:*:nL1N2R91JB
JPMorgan Chief Executive Officer Jamie Dimon told analysts
last month that banks "should be worried" that high inflation
and high interest rates increase the risk of extreme price
movements.
A sustained period of higher inflation would pose both
credit and market risk to banks, and they are assessing that
risk in internal stress tests, said one senior banker at a
European bank with large U.S. operations.
Risk teams are also monitoring credit exposures in sectors
most affected by inflation, another banker said. They include
firms in the consumer discretionary, industrial and
manufacturing sectors.
"We are very active with those clients, offering hedging
protections," said the banker, who asked not to be named as
client discussions are confidential.
Clients that may need extra funding to get them through a
period of higher inflation are being advised to raise capital
while interest rates remain relatively low, the banker said.
"It's still a very beneficial environment to be in if you
need funding, but that won't last forever."
Investment bankers are also assessing whether higher
inflation and monetary tightening could disrupt record deals and
public offering pipelines.
"We expect a sustained period of higher inflation, and
monetary tightening could slow the momentum in the M&A market,"
said Paul Colone, U.S.-based managing partner at Alantra, a
global mid-market investment bank.
Alantra is advising clients in the early stages of M&A
discussions "to review the risks sustained inflation could bring
to both valuation and business results," Colone said.
Sales and trading teams, meanwhile, are taking more calls
from clients looking to reposition portfolios, which are
vulnerable to a loss in value. When inflation ran out of control
in the 1970s, U.S. stock indices were hit hard.
"We're seeing more interest from clients in finding some
manner of inflation protection," said Chris McReynolds,
Barclays' head of U.S. inflation trading.
Treasury Inflation Protected Securities, which are issued
and backed by the U.S. government, are proving popular, he said.
The securities are similar to Treasury bonds but come with
protection against inflation.
Traders are also seeing demand for derivatives that offer
inflation protection such as zero-coupon inflation swaps, in
which a fixed rate payment on an investment is exchanged for a
payment at the rate of inflation.
"People are realizing they have inflation exposure and it
makes sense for them to hedge their assets and liabilities,"
McReynolds said.
Banks with diversified businesses are likely to fare best
during a sustained period of inflation, most analysts say.
They expect that a steepening yield curve will boost overall
profit margins, while trading businesses can benefit from
increased volatility and the strength of deals, and initial
public offering pipelines mean investment banking activity will
remain healthy.
But Dick Bove, a prominent independent banking analyst,
takes a different view. He anticipates the yield curve will
flatten as higher rates reduce inflation expectations, crimping
profit margins.
"Perhaps for as long as 12 to 18 months, bank stock prices
will rise," he said. "At some point, however, if inflation
continues to rise, the multiples on bank stocks will collapse
and so will bank stock prices."
(Reporting by Matt Scuffham; Editing by Dan Grebler)
((matthew.scuffham@thomsonreuters.com; +1-416-687-7591; Reuters
Messaging: matthew.scuffham.reuters.com@reuters.net))